Social Impact Bonds: A New Model to Reduce Blight

Abandoned properties and vacant lots abound in decaying Rust Belt neighborhoods struggling with manufacturing losses and entrenched segregation. The problem is no less serious in the Sun Belt, where overzealous developers left neighborhoods half-built and overconfident consumers now face waves of foreclosures.

And in every city there are investment property owners playing the moral hazard game—they will only clean up their property when enough others do so that they can profit.

Unfortunately, cities have few effective ways to fight blight. Although cities want to reduce the number and impact of blighted places and have owners of vacant or underutilized properties clean them up, they must tread cautiously. The worst case scenario is that they use too big a hammer, the owner walks away, and the burden is left to the city to develop and maintain these spaces.

But there may be a new tool in the war on blight: a relatively new financial instrument known as the social impact bond (SIB). The idea behind SIBs is that private investors, not the government, bear the risk for large-scale, pricey endeavors designed to build and maintain America’s social service infrastructure.

Social impact bonds are being used to inject private funds into public-sector programs to provide prevention services to vulnerable individuals.

If the program is successful—that is, if the recidivism rate is less than would be the case without these services—New York City will re-pay Goldman its investment plus a profit. If the program fails, Goldman will not be compensated.

SIBs are currently being used to invest in people, not places. But, for cities looking to innovate, SIBs may provide a promising model for funding reclamation of blighted areas that cities inherit or want to develop.

Under this model, private capital would be used to support revitalization projects, and cities would provide investors a cut of the revenue if the developments prove profitable.

Using SIBs this way has some advantages over people-focused prevention programs. Unlike the Rikers SIB, where ‘savings’ from reduced recidivism are unlikely to flow back in the government’s coffers, cities would clearly identify savings in development and maintenance costs, plus reap the reward of increased revenue from more successful uses of now dormant properties.

The Gulch produced over $115,000 per acre in net revenue and generated $3,300 per unit in property taxes, sales taxes, and additional revenue each year, but cost the city only $1,400 per unit in annual maintenance fees for infrastructure upkeep as well as fire and police response services.

So the calculus here is simple. The SIB funds the takeover of problem properties. Then, the city works with commercial developers to design a vision for the space that does more than turn a quick profit, with the SIB investment covering the difference between a socially beneficial project and one focused solely on profit maximization.

The government receives more than twice the revenue that it pays for maintenance, guaranteeing a long-term stream of revenue that is more than enough to pay back the SIB principal plus a profit, and to finance future investments.

Development of blighted areas is both a top priority and a risky financial endeavor for cash-strapped cities. But American cities would benefit immensely by incentivizing the development of these areas through social impact bonds.